By Padraic Halpin
DONEGAL, Ireland (Reuters) - Ireland's government said it was confident it would be able to pass the toughest budget in the country's history next month despite its expected defeat in a by-election on Thursday.
Dublin's efforts to cut the worst deficit in Europe will form the basis of an 85 billion-euro bailout from the IMF and the EU. Failure to pass the 2011 plan would deepen the country's crisis and destabilize the euro zone.
"I am quite satisfied from my discussions both with the parties in government and the various public representatives in Dail Eireann (parliament) that there is a majority for this budget and that it will pass," Finance Minister Brian Lenihan said in a speech to the American Chamber of Commerce in Dublin.
Prime Minister Brian Cowen's parliamentary majority is set to shrink to just two when votes in the by-election in the northern county of Donegal are counted on Friday.
Lenihan's comments suggest the government may have won over two independent MPs who signaled earlier this week that they might not support the 2011 plan, the first in a series of austerity budgets.
The government's four-year plan, unveiled on Wednesday, has failed to impress investors and its harsh measures, including a cut to the minimum wage, have fueled complaints that taxpayers are being punished to bail out bankers and property developers.
Cowen's Fianna Fail party are set for a record drubbing in the next general election, likely early in 2011. In Donegal, many voters were exacting an early revenge.
Opinion polls suggest Pearse Doherty, the candidate for Sinn Fein -- the small, pro-labor opposition party that wants to unite the Irish republic with British-ruled Northern Ireland -- will win the seat in Donegal South West.
"My family has always voted for Fianna Fail but they've all changed to Sinn Fein the last couple of years because of the way the country is," said Christopher Breen, a 25-year-old local soccer player.
BONDHOLDERS "SHOULD TAKE A HIT"
The center-right Fine Gael, which is likely to lead the next government, said it would not be bound by the terms of the four-year plan and would not cut the wages of the lowest paid.
Fine Gael also said it would be prepared to make senior bondholders in banks take some of the hit for purging the sector of years of reckless lending.
"We have to take the view that people who invested and invested unwisely have the consequences under capitalism of losing some or all of their investment," said Richard Bruton, Fine Gael's spokesman on enterprise.
Despite government assurances to the contrary, rumors persist that Irish senior bank debt may be restructured as part of negotiations with the IMF and the EU for a bailout package for Ireland and its banks, totaling around 85 billion euros.
A European Commission spokesman said on Thursday that those talks, which are taking place in Dublin, would be wrapped up by the beginning of December.
Concern over the terms of any bailout and skepticism that the four-year plan can achieve its goals sent the cost of insuring Irish debt against default up 19 basis points on Thursday to 600 bps.
Irish borrowing costs remain elevated, with the yield on 10-year paper over 9 percent, well over three times the rate on German paper.
Adding to the negative sentiment, European clearing house LCH.Clearnet increased the margin requirement on Irish government bonds for the third time in two weeks.
Despite the prospect of years of cutbacks, there has been little sign of social unrest in Ireland and some people in Dublin were taking a philosophical view.
"A lot of people are affected, and it puts pressure on them," said Mark O'Carroll, a 20-year-old student. "But the best things in life are free, I enjoy the outdoors and you can't tax that."
(Writing by Carmel Crimmins; additional reporting by Lorraine Turner and Jodie Ginsberg; editing by Andrew Roche)